Rob Southey, Head: Asset Consulting at Momentum Consultants and Actuaries

1 September 2024 will see the introduction of the Two Pot System.  Depending on how members behave towards the additional withdrawal flexibility, this could have long term implications for members’ retirement savings. While members will be able to withdraw from their Savings components, wholesale withdrawals of retirement savings will no longer be possible when resigning from an employer – barring any vested portion. The implications of this are self-evident. Not so obvious though is whether there should be a difference between the investment strategies of the Retirement and Savings components.

Retirement funding is long term in nature.  Conventional wisdom says that a member’s investment strategy should be structured accordingly. For example, the strategy for a 30-year-old member should target long term returns of CPI+5% or greater, as the strategy is not impacted by short term market volatility given the longer term nature of the investment. On the other hand, a member close to retirement cannot tolerate significant volatility, so the return objective should be lower. But what about someone who is likely to make frequent withdrawals from their Savings component? Is this member likely to want these assets to be exposed to market volatility? Probably not.

In this article, we do not make recommendations on whether investment strategies for Savings and Retirement components (or pots) should be the same or not. That will be client specific.  Trustees and advisory bodies will need to make that decision based on the specific needs of their membership. They will also need to factor in the capabilities of their administrator, as not all administrators will be able to cater for different investment strategies for the Savings and Retirement components from the get-go. Below we demonstrate the impact on retirement outcomes based on different investment strategies and different withdrawal behaviours being applied.

The results

We show the different scenarios based on different investment strategies and/or withdrawal behaviours below.

We assume that the long term return from a typical lifestage investment strategy will be CPI + 4.7% p.a. and the return of a conservative money market strategy will be CPI + 1% p.a. These returns will be different for different funds, but the principle remains the same.

We also assumed:

• A member starts working at 25 and retires at 60
• The member contributes 14% p.a. to retirement funding
• Salary inflation is CPI + 1% p.a.
• Inflation or CPI is 5% p.a.

Scenario 1 – The impact on the net replacement ratio (NRR) of different strategies, assuming no withdrawals are made

Here we show the implications of various investment strategies on the member’s NRR assuming that the member makes no withdrawals during their working life.

The net replacement ratio is the annual pension in the first year of retirement divided by the pensionable salary of the member in the year before retirement.

This shows that there is a 10% drop in the expected NRR for a member having their Savings component assets invested in a conservative strategy (Strategy 2) relative to the long term lifestage strategy (Strategy 1) even without the impact of making withdrawals. Strategy 3 is included simply for illustrative purposes, as it is unlikely any fund will have their assets invested in such a conservative manner.

Scenario 2 – The impact of different investment strategies in Rand terms

For the purposes of this scenario, we demonstrate retirement fund values for a member making no withdrawals from his Savings component compared with a member making withdrawals of R100 000 every 5 years. We have assumed each member has a starting pensionable salary of R20 000 per month. All other assumptions remain as before. It is obvious that the more conservative the investment strategy, and the higher the withdrawal rate, the lower the retirement value will be.

Scenario 3 – The impact of a large, once-off withdrawal

In this scenario we assume the member makes one large withdrawal, to the value of 50% of their Savings component, at different ages. This shows that the older you are, the bigger the impact on your retirement fund value for a significant withdrawal. This makes sense as the withdrawal value is larger and there is not sufficient time left before retirement for compounding to increase the value significantly again. The values in today’s money are shown in brackets.

Scenario 4 – We assume different vested values with subsequent withdrawals

In this scenario, we are assuming that we have two different members, both 50 years of age at the commencement of the Two Pot System. We assume that one has a vested value of R2m at 1 September 2024 and the other a vested value of R4m. We look at the impact of emptying the Savings component at age 55. This scenario shows the effect on members aged 50 on the date of the introduction of the Two Pot System in 2024. It shows that the impact of withdrawing from the Savings component is not particularly penal. This is primarily because the 1/3 contribution to the Savings component does not become very big relative to the size of the Vested and Retirement components.  The Vested component follows the lifestage investment strategy, as expected.  The values in today’s money are shown in brackets.

Summary

The purpose of this note is to demonstrate the impact on members’ retirement values of different investment strategies between the Retirement and Savings components, as well as different withdrawal strategies. In short, for members fairly close to retirement at the introduction of the Two Pot System, the impact of different investment strategies and withdrawing from the Savings component is fairly limited. This is because the value of the Savings component will still be small, and the compounding effect does not have much time to significantly influence the expected retirement value. For younger members however, the impact of different investment strategies AND withdrawals is significant.

Trustees and advisory bodies will need to apply their minds to what is in the best interests of their members and will need to take into consideration member behaviour. This will only be known after the implementation of Two Pot System as the actual behaviour unfolds over time. Trustees and advisory bodies will then be better informed and will be able to make modifications to the Savings component investment strategy if deemed necessary or appropriate.

What is clear though, is that the best retirement outcome for members requires that they retain the same long term strategy between the Retirement and Savings components and do not make any withdrawals.

Also watch the video interview with Rob

ENDS